Sunk Cost

Sunk Cost

In the field of management accounting word sunk costing is very commonly known, in economics and business world sunk costs means irrelevant cost i.e. the cost which is not relevant in decision making process. In simple words Sunk cost is a cost which has already been incurred and it cannot be recovered or reversed. It’s important to understand sunk cost concept because sunk cost and decision making are correlated to each other and for efficient decision making identifying sunk costs is very important. In order to understand the concept of sunk cost better we must first determine all type of costs and how they affect the decision making process. Costs can mainly be classified as relevant costs, irrelevant costs, sunk costs and opportunity costs, to understand the relevance of sunk cost we have to first understand other types of costs.

Relevant costs and revenues

Before taking any decision management has to first analyze the relevant costs and revenues associated with the project. Relevant costs and revenues are those costs and revenues are those costs and revenues that would occur in future and will be changed by changing the decision whereas irrelevant costs and revenues are those future costs and revenues which will not change by changing decision, irrelevant cost will remain same in each alternative. In other words, relevant cost and expenses are future cash flows that differ between the alternatives considered.

Sunk Cost and irrelevant cost

Sunk cost is a cost which will continue to occur with the same amount no matter which option is being chosen also it will continue to occur no matter any option is being chosen or not i.e. sunk cost is a cost which an organization has to incur even if no option is chosen e.g. depreciation.

Sunk Cost can be defined as the costs which are irrelevant for decision making and they must be ignored for every type of decisions. These are the past or historical costs which have already been incurred before taking any...